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Commissioner Of Income-Tax, Tamil Nadu-V v. O.M.S.S Sankaralinga Nadar & Co.
Structured Summary of the Legal Opinion (Balasubrahmanyan, J.)
Factual and Procedural Background
The assessee is a partnership firm engaged in trading cereals, pulses and tamarind at Virudhunagar. For the account year ended 7 September 1975 the firm incurred Rs. 3,622 on refreshments supplied to customers. The Income-tax Officer (ITO) disallowed this entire expenditure under section 37(2B) of the Income-tax Act, 1961. On appeal the Appellate Assistant Commissioner (AAC) and the Income-tax Appellate Tribunal (Tribunal) considered the nature of the expenditure; the Tribunal found it represented petty costs of supplying coffee, tea and refreshments and allowed the expenditure as a deduction.
A separate contested point concerned interest charged by the firm to a partner, Natarajan. The ITO had added back Rs. 783 as interest payable by the firm to that partner under section 40(b) of the Income-tax Act, 1961. The assessee contended that the firm and partner had reciprocal accounts (capital account showing amounts payable by the firm to the partner, and a drawings account showing a debit balance in which the partner owed interest to the firm), and that interest should be considered on a net basis after set-off between these accounts. The AAC accepted the assessee's netting approach and disallowed only the net interest. The Tribunal agreed with the AAC and relied on certain Allahabad High Court decisions and a Board circular.
The Department was aggrieved on both points (the allowance of Rs. 3,622 and the AAC/Tribunal's approach to interest) and the Tribunal referred two questions of law to this Court for opinion:
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the entertainment expenses of Rs. 3,622 are admissible as business expenses notwithstanding the prohibition contained in section 37(2B) of the Income-tax Act, 1961?
- Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that only the net interest should be disallowed under section 40(b) of the Income-tax Act, 1961?
Arguments of the Parties
Assessee's Arguments
- The Rs. 3,622 expenditure represented petty costs (coffee, tea and refreshments) for customers and was not "entertainment" within the meaning of s. 37(2B); therefore it should be allowable as a business deduction.
- With respect to interest under s. 40(b), the firm and the partner had reciprocal entries: the capital account reflected interest payable by the firm to the partner (gross interest Rs. 783) while the drawings account showed a debit balance on which the partner owed interest to the firm. The assessee argued that the statutory disallowance should take into account both accounts and permit set-off so that only net interest (if any) payable by the firm to the partner would be disallowable.
Department's Arguments
- The ITO treated the Rs. 3,622 outgo as falling within the prohibition of s. 37(2B) and disallowed it as entertainment expenditure.
- On s. 40(b), the Department opposed the netting/set-off approach and treated the amount added back (Rs. 783) as interest paid by the firm to the partner that must be disallowed under the statute; the Department appealed the AAC's and Tribunal's contrary conclusions.
- The Department (as reflected by the Tribunal's discussion) relied upon certain Allahabad High Court decisions and a Board circular which, in practice, had led earlier authorities to permit only netting in some instances (the Tribunal relied on those authorities and the circular when deciding in favour of the assessee).
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner Of Income-Tax, Tamil Nadu-I v. Karuppuswamy Nadar & Sons, [1979] 120 ITR 140 (Mad) | That petty expenses on refreshments supplied to customers are elementary courtesy and not entertainment within s. 37(2B) — thus allowable as business expenses. | The Court followed and applied this decision to answer the first question in favour of the assessee, holding the Rs. 3,622 to be allowable. |
| Sri Ram Mahadeo Prasad (Applicant) v. Commissioner Of Income-Tax (Opposite-Party), [1953] 24 ITR 176 (All) | An earlier Allahabad High Court decision that endorsed the Tribunal's disallowance of only net interest — the reasoning was described in the opinion as based on fairness/equity rather than statutory construction. | The Court noted this decision as part of a string of Allahabad authorities but distinguished it because it rested on equitable considerations rather than on an interpretation of the statutory words; the Court declined to follow that equitable approach when construing s. 40(b). |
| Commissioner Of Income-Tax v. London Machinery Co., [1979] 117 ITR 111 (All) | Cited as one of the Allahabad High Court decisions in the line of authorities that had treated netting of interest as permissible. | The Court observed that these decisions did not undertake a textual interpretation of s. 40(b) and therefore were not persuasive for statutory construction; the Court rejected reliance on them for construing the section. |
| Sri Ram Mahadeo Prasad…, [1979] 120 ITR 149 (All) | Another Allahabad decision in the chain of cases touching on disallowance of interest and netting. | The Court treated this and similar decisions collectively as not having interpreted the section's language and thus not determinative of the statutory meaning; their equitable basis limited their precedential value for construction. |
| CIT v. Kailash Motors, [1982] 134 ITR 312 (All) | Cited as part of the sequence of Allahabad decisions relating to netting of interest between partner and firm. | The Court recorded the existence of this authority in the chain but declined to accept the netting approach as a matter of statutory interpretation, preferring a textual reading of s. 40(b). |
Court's Reasoning and Analysis
The Court addressed the two referred questions separately and applied textual analysis and precedent where applicable.
Question 1 — s. 37(2B) (Entertainment Expenses)
- The Tribunal had found that the Rs. 3,622 represented the cost of supplying coffee, tea and other refreshments to customers and characterised the items as petty and not lavish. On that factual finding the ITO had no warrant to treat the outgoings as caught by s. 37(2B).
- The Court relied on this factual finding and on the Court's own prior decision in Commissioner Of Income-Tax, Tamil Nadu-I v. Karuppuswamy Nadar & Sons, which treats similar petty refreshments as elementary courtesy and allowable. For these reasons the Court agreed with the Tribunal and allowed the deduction.
Question 2 — s. 40(b) (Interest Paid to a Partner)
- The Court analysed the language of s. 40(b), noting that it is a replica of s. 10(4)(b) of the Indian Income-tax Act, 1922, and that the provision lists "any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm" as amounts not deductible in computing a firm's income.
- The Court reasoned from the collocation of terms: salary, bonus, commission and remuneration are items that are single-direction payments from the firm to the partner and are disallowed as such; they do not admit of a "net" character by way of reciprocal set-off. By parity of reasoning, when the section speaks of "payment of interest" by the firm to a partner, the disallowance contemplates interest as such in a particular account (i.e., gross interest payable by the firm in that account), not a net figure arrived at after accounting for interest payable by the partner to the firm in a separate account.
- The Court explicitly rejected the assessee's argument that inter-account set-off should govern the statutory disallowance. It concluded that the words of the section do not permit construing "payment of interest" as meaning "net interest" after reciprocal adjustments.
- The Court reviewed the line of Allahabad High Court decisions relied upon by the Tribunal and noted that those courts did not base their conclusions on statutory construction; rather, at least in the earliest case, the decision to permit netting was grounded on equitable considerations of "fairness." The Court emphasised that equity and income-tax law are distinct and that equitable considerations do not displace the statutory meaning.
- The Court also declined to treat the Central Board of Direct Taxes (CBDT) circular as a controlling aid for statutory construction, observing that such circulars are not binding on the Court and can be inconsistent; the Court refused to follow the circular in lieu of construing the statute itself.
- On this basis the Court answered the second question in favour of the Department and against the assessee, holding that s. 40(b) requires disallowance of interest paid by the firm to a partner as such (gross interest in the particular account) and does not permit automatic netting against interest payable by the partner in a separate account.
Holding and Implications
The Court issued a mixed holding on the two referred questions:
- Question 1 — Allowed for the assessee: The Court held in favour of the assessee that the Rs. 3,622 expenditure on coffee, tea and refreshments was not caught by s. 37(2B) and is allowable as a business deduction (following Commissioner Of Income-Tax, Tamil Nadu-I v. Karuppuswamy Nadar & Sons).
- Question 2 — Allowed for the Department: The Court held in favour of the Department that s. 40(b) contemplates disallowance of interest paid by the firm to a partner as such (i.e., gross interest in the relevant account) and does not authorise a statutory set-off against interest payable by the partner in a separate drawings account; therefore the AAC/Tribunal's approach permitting netting was rejected.
Direct consequences: the deduction of Rs. 3,622 is upheld for the assessee; the add-back of interest (Rs. 783) treated by the ITO as interest paid by the firm to the partner stands to be disallowed under s. 40(b) in accordance with the Court's construction. The opinion contains no direction as to costs (the Court ordered no costs).
This summary is confined strictly to information contained in the provided opinion.
Balasubrahmanyan, J.:— There are two questions of law which have been referred to us by the Income-tax Appellate Tribunal in this reference arising under the I.T Act, 1961.
2. The assessee in this case is a partnership firm carrying on business in cereals, pulses and tamarind at Virudhunagar. During the account year ended September 7, 1975, the assessee firm spent Rs. 3,622 in relation to customers who visited the assessee's place of business. The ITO disallowed the entire expenditure under s. 37(2B) of the Act. On appeal, the Tribunal went into the nature of the expenditure and found that it represented the cost of supply of coffee, tea and other refreshments to the assessee's customers. According to the Tribunal, these expenses were petty in nature and could hardly be regarded as entertainment expenditure, because there was nothing lavish or entertaining about it. On this ground, the Tribunal set aside this part of the assessment order of the ITO and allowed the entire expenditure of Rs. 3,622 to be allowed as an admissible deduction. One other point which was the subject of, controversy between the Department and the assessee was as to the quantum of add-back of interest paid by the assessee firm to one of its partners by name Natarajan. The relevant statutory provision which enjoins a disallowance, or add-back, of interest paid to a partner in the firm's total income is set out in s. 40(b) of the I.T Act, 1961. The amount added back by the officer in this case was Rs. 783 only. But the assessee-firm made a point of principle out of it and took the matter in appeal before the Tribunal. The assessee's case was that Rs. 783 only represented the gross interest payable by the firm to the partner, Natarajan, on amounts standing to his credit in the capital account of the firm. The assessee, however, referred to another account of the partner, Natarajan, called drawings account, with the firm. In this account, apparently, the partner was effecting his drawings of money from the partnership. Apparently, again, this drawings account showed a debit balance. The assessee-firm charged the partner with interest on the debit balance in this drawings account. The case of the assessee was that for the purpose of disallowance of the interest paid by the assessee-firm to its partner, account must also be taken of the interest payable by Natarajan to the firm and only after a combined consideration and mutual set-off of interest in both the accounts, the question of disallowance of net interest, if any, payable by the firm to the partner can be the subject of disallowance.
3. This claim of the assessee was accepted in appeal by the AAC. According to that appellate authority, the firm and the partner must be regarded as being placed in a single jural relationship. The point decided was that although there were two accounts of the partner, Natarajan, the capital account and the drawings account, the two cannot be regarded as different or independent accounts, so far as the accounting with the firm was concerned. According to the AAC, therefore, what has to be disallowed under the Act as payment to the partner can only be the net interest paid by the firm to the partner.
4. Against this understanding of s. 40(b) of the Act by the AAC, the Department went in appeal to the Tribunal. The Tribunal, however, agreed with the view expressed by the AAC. They relied on certain decisions of the Allahabad High Court in support of their determination. They relied also on a Board circular on the subject.
5. Since the Tribunal's decision had gone against the Department on two points, viz. (1) on the allowance of expenditure in the sum of Rs. 3,622 and (2) non-allowance of interest of Rs. 783 paid by the firm to the partner, the Department demanded a case to be stated to this court from the Tribunal. The Tribunal has since made a reference on the following questions of law for our opinion:
“1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the entertainment expenses of Rs. 3,622 are admissible as business expenses notwithstanding the prohibition contained in section 37(2B) of the Income-tax Act, 1961?
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that only the net interest should be disallowed under section 40(b) of the Income-tax Act, 1961?”
6. On the first question, there is no need to discuss the matter at any length, for, on the finding of the Tribunal that the expenditure of Rs. 3,622 was only the sum-total of petty items relating to the cost of coffee, tea and other refreshments, incurred by the assessee for their customers, there was no warrant for the ITO for regarding the outgoing as hit by s. 37(2B) of the I.T Act, 1961. Similar expenses have been regarded by this court as being merely the manifestation of elementary courtesy which the assessee while carrying on the business extended, or was expected to extend, to their constituents, vide Commissioner Of Income-Tax, Tamil Nadu-I v. Karuppuswamy Nadar & Sons. and Sons, [1979] 120 ITR 140 (Mad). We answer the first question in favour of the assessee and against the Department, following that decision.
7. The second question as to the non-disallowance of the interest payment made by the firm to the partner, Natarajan, in the computation of the firm's total income has to be considered in the language of s. 40(b) of the Act. This provision is a replica of s. 10(4)(b) of the Indian I.T Act, 1922. These provisions relate to the computation of the total income of an assessee who is a partnership firm. Section 40(b) of the Act refers to “‘any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm’, as an amount which shall not be deducted in computing the income of a firm under the head ‘profits and gains of business or profession’.” The Officer had disallowed the sum of Rs. 783 in this case because it was interest paid by the assessee-firm to the partner, Natarajan. It cannot be denied that the amount is interest paid by the firm to the partner. What is claimed by the assessee, however, is that in an independent account called the drawings account, the firm has to receive interest from the same partner concerned, because that account has been overdrawn by him. According to the assessee, the expression “any payment of interest” occurring in s. 40(b) only refers to the net interest arrived at by taking all the accounts inter se between the firm and its partner.
8. We do not accept this contention as warranted by the words of the section. We have earlier quoted verbatim from the crucial words of the section. The collocation of the words shows that what is disallowed in the matter of payment of interest cannot be the net interest, but can only be interest paid with reference to a given account relating to payment of interest by the firm to the partner. This is because the subject of disallowance in the matter of payment of interest appears in s. 40(b) cheek by jowl with salary, bonus, commission or remuneration made by the firm to the partner. There cannot be any net salary or net bonus or net remuneration as matters of disallowance. They can only be salary, as such, or bonus, as such, or commission, as such, or remuneration as such which are the subject of disallowance. In like manner, when the section speaks of payment of interest by the firm to a partner as the subject of disallowance, it can only be payment of ‘gross’ interest in the particular account in which interest is payable. Salary, bonus, commission or remuneration do not have what may be characterised as a two-way traffic. Salary is payable only by the firm to the partner. Bonus, commission or remuneration are similarly payable by the firm to the partner and this is the reason why they are all disallowed. There can be no scope, therefore, of any setoff on account of any dues under these heads owed by the partner to the firm. In this collocation of ideas and expressions, therefore, we cannot construe the payment of interest occurring in the section as payment of net interest.
9. Learned counsel referred to a string of decisions from the Allahabad High Court, beginning from Sri Ram Mahadeo Prasad…(Applicant); v. Commissioner Of Income-Tax…(Opposite-Party)., [1953] 24 ITR 176 (All), down to CIT v. Kailash Motors, [1982] 134 ITR 312 (All). In between, there are two other decisions of the same court Commissioner Of Income-Tax v. London Machinery Co., [1979] 117 ITR 111 (All) and Sri Ram Mahadeo Prasad…(Applicant); v. Commissioner Of Income-Tax…(Opposite-Party)., [1979] 120 ITR 149 (All). In all these decisions, we do not find any effort expended on the interpretation of s. 40(b), or its precursor, s. 10(4)(b) of the 1922 Act. In the earliest of the cases, the Allahabad High Court endorsed the Tribunal's decision to disallow only the net interest. The court did so, not on a construction of the words of the section, but on equitable grounds of “fairness”. The following observation in that case, makes clear the basis of the court's judgment (p. 184 of 24 ITR):
“The Appellate Assistant Commissioner and the Tribunal thus treated the assessee most fairly and our answer to the second question is in the affirmative.”
(Underlining* ours).
10. There is a saying that income-tax and equity are strangers. The Allahabad decisions have only laid down what, according to that High Court, is equitable. They have not laid down the construction of the relevant statutory provision.
11. Learned counsel pressed on us the departmental circular which was relied on by the Tribunal. When a matter comes before this court for an advisory opinion on the state of the law or of a fiscal principle, or on the construction of any provision in the taxing enactment, the last place where we should look for aid or guidance would be a circular from the CBDT on the subject. We are not bound by the Board circulars. Besides, these circulars have the knack of being inconsistent. For, they are, for the most part, circulars for the occasion. We are not, therefore, inclined even to take a look into the circular referred to us. If the circular has expressed a view which the Department has not followed in this case, the remedy is not to ask this court to render an opinion in accordance with the circular. The relief has to be sought elsewhere. It would be quite different from what or how a court of advisory jurisdiction would render on the merits. Be that as it may, for the reasons which we have earlier stated, our answer to the second question is in favour of the Department and against the assessee.
12. In view, of the mixed results of the reference, there will be no order as to costs.
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